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Flights to Safety Can’t Hide the Dangers

THE pattern has been repeated so many times that it might be comforting if it weren’t so disturbing.

During a relatively calm stretch early in the year, the stock market rallied. But then the financial and political problems of the euro zone made headlines. At the same time, the outlook for the global economy dimmed.

Stock markets around the world began to stumble. Investors reduced the level of risk in their portfolios and started to pour their cash into all the usual places, with United States Treasuries near the top of just about everyone’s list. A bond rally was in full swing again.

“When people are worried, all roads lead to Treasuries, and that just doesn’t seem likely to change anytime soon,” said Kathy A. Jones, fixed-income strategist at Charles Schwab.

Even in an election year in the United States, with fiscal policy in a state of disarray and with a budget deficit of more than $1 trillion, Treasuries remain in great demand. Last week, prices rose, and 10-year yields fell as low as 1.84 percent.

German government bonds have been another consistent favorite for risk-averse investors over the last few years. Last week, despite pressure on Germany to shoulder more of the euro zone’s debt burden, they were, if anything, even more highly prized than Treasuries. Yields on 10-year bunds, as they are called, touched 1.49 percent during the week. And in Britain, where the government has been slashing costs, long-term bond yields fell to 1.88 percent — the lowest since the Bank of England started collecting data in 1703, according to The Financial Times.

"We are living in very unusual times," said Mohamed A. El-Erian, the chief executive of Pimco, the world’s largest bond manager. “History may not be as reliable a guide as it’s been in the past.”

JPMorgan Chase’s disclosure on Thursday night that it had lost an estimated $2 billion in a portfolio of credit investments put pressure on financial stocks on Friday, contributing to the global equity sell-off and to the bond market’s momentum. But this month’s elections in the euro zone were perhaps the most immediate cause of last week’s flight to safety.

In Greece, voters repudiated the government that had negotiated its bailout, placing the country’s future in the euro zone in doubt. In the French presidential election, voters embraced François Hollande, the Socialist candidate, who demanded an end to single-minded budget-cutting for its own sake and called for a new “growth compact” for Europe.

“Obviously,” Ms. Jones said, “the people have spoken in Europe and they don’t like austerity.” Bond investors tend to like austerity, however, because it may increase the likelihood that debt will be repaid. While traders flocked to Germany and Britain for sovereign bonds, they drove down prices of bonds perceived as riskier, like Spain’s; yields on its bonds moved above the critical 6 percent level for a time last week.

CONCERN about a “soft patch of economic data,” including a slowdown in China and a disappointing United States employment report, also weighed on investors, said Scott Minerd, chief investment officer at Guggenheim Partners. He says the long-term trend for government bond yields is “undoubtedly upward,” but adds that its emergence has been delayed by the protracted economic malaise.

“Right now, if the economy slows down further, bond yields could go even lower,” he said, suggesting that the Federal Reserve would be likely to intervene again in an effort to stimulate the economy.

Sovereign bond yields have traditionally defined the “risk-free rate” used to value a vast array of financial assets and investments, but after the traumas of the last few years, these yields are so low that such valuations are very hard to make, said Aswath Damodaran, a finance professor at New York University. “I think the main factor holding long-term rates down now is very weak global economic growth, and I don’t see that changing soon,” he said. One indication that the world had truly recovered from the financial crisis would be a rise in 10-year Treasury yields to 4 percent, he said, but he did not see that prospect as imminent.

David Rosenberg, chief economist and strategist at Gluskin Sheff in Toronto, has been writing bearish reports on the equity markets and the global economy for many months. He said in an interview that the debilitating effects of “global debt deleveraging” would continue for the foreseeable future. The economic recovery in the United States is precarious, he said, and “gridlock in Washington at this moment is not contributing to a solution of the country’s problems.”

He cited Ben S. Bernanke, the Federal Reserve chairman, who has warned that unless Congress and the White House take action later this year, the United States could hurtle over a “massive fiscal cliff.” That’s a reference to the impending Dec. 31 expiration of the tax cuts of President George W. Bush, and to the start of billions of dollars of across-the-board spending reductions passed in last year’s deal to raise the debt ceiling. Combining the tax increase and spending cuts would ensure a recession, Mr. Rosenberg said.

Government action to forestall these effects is urgent, Mr. El-Erian said. “It’s only a matter of weeks before the markets begin to really focus on that ‘fiscal cliff,’ ” he said. “It hasn’t really been priced into the market.”

If these fiscal issues aren’t resolved, he said, there will probably be far greater market volatility than we have seen recently, with major declines in stocks and a further rally in bonds. Investors would want to have “some dry powder” — cash on hand — to avoid excessive losses and to take advantage of opportunities that arise, he said.

We can’t derive too much comfort from the repetition of patterns in the markets, he said, noting the adage that while history doesn’t repeat itself, it rhymes. “At some point,” Mr. El-Erian said, “it will stop rhyming.”

A version of this article appears in print on May 13, 2012, on Page BU6 of the New York edition with the headline: Flights To Safety Can’t Hide The Dangers. Order Reprints|Today's Paper|Subscribe